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The Unitrust Solution | Annual Beneficiary Income from 3% to 5%

Unitrust Income for Beneficiaries.jpgWe've all heard or said something like: "How would you like it if someone did the same thing to you?" It's a heartfelt question. It calls to mind our willingness to consider another viewpoint - to empathize.

In the words of the poet Mary T. Lathrap's "Judge Softly:"

"Brother, there but for the grace of God go you and I.
Just for a moment, slip into his mind and traditions
And see the world through his spirit and eyes
Before you cast a stone or falsely judge his conditions.

Remember to walk a mile in his moccasins
And remember the lessons of humanity taught to you by your elders.
We will be known forever by the tracks we leave
In other people's lives, our kindnesses and generosity.

Take the time to walk a mile in his moccasins."

Now, why would I bring this up when it comes to trust beneficiaries? It comes from my own experience - my own walk.

We represent trust beneficiaries in common trust and trustee challenges. We often appeal to a certain standard of behavior which we expect our opposition to know about. A standard deep in our culture - in our learning - is the golden rule: "Do unto others as you would have them do unto you."

Sometimes our appeal succeeds. We move toward resolution. Toward peace.

And sometimes our appeal doesn't succeed. We seek out justice. And, "justice is the settled and permanent intention of rendering to each man his rights." Sometimes justice seems so obvious. Yet, I know that it isn't.

Maybe I've not walked a mile in the other person's moccasins. Or, they've not walked a mile in mine. All of these thoughts to get to one point - one observation - on the seemingly prosaic subject of beneficiaries and trusts.

Parents establish trusts for the benefit of their children and their children's descendants. Common terms include net income during the lives of their children, and at their children's death, income distribution to their grandchildren. These trusts are frequently administered by banks and trust companies. And in some circumstances, trustee fees exceed beneficiary distributions.

I've seen many circumstances where trust beneficiaries are only receiving about 1% income on trust assets while banks or trust companies are paying themselves annual fees in excess of the annual beneficiary distributions. Few would argue that this result was the expressed or unexpressed desire of the trust maker, the grantor.

Trust scholars, state legislatures and even the IRS have addressed a cure.

"The IRS and the Treasury Department recognize that state statutes are in the process of changing traditional concepts of income and principal in response to investment strategies that seek total positive return on trust assets. These statutes are designed to ensure that, when a trust invests in assets that may generate little traditional income (including dividends, interest, and rents), the income and remainder beneficiaries are allocated reasonable amounts of the total return of the trust (including both traditional income and capital appreciation of trust assets) so that both classes of beneficiaries are treated impartially. Some statutes permit the trustee to pay to the person entitled to the income a unitrust amount based on a fixed percentage of the fair market value of the trust assets."

California specifically provides that unless "expressly prohibited by the governing instrument, a trustee may convert a trust into a unitrust..." California's permissible range of unitrust percentages encompasses a wide range of economic conditions:

"In no event ... may the court authorize conversion to a unitrust with a payout percentage of less than 3 percent or greater than 5 percent of the fair market value of trust assets." California Probate Code Section 16336.5."

Moreover, a "beneficiary may petition the court to order the conversion."

So, getting back to our opening question - "How would you like it if someone did the same thing to you?"- a question that I would pose to bank trustees or trust companies (and their counsel) that are currently administering income trusts. And what is the act that seems unfair?


What is a unitrust?

  • A unitrust is designed to ensure that, when a trust invests in assets that may generate little traditional income (including dividends, interest, and rents), the income and remainder beneficiaries are allocated reasonable amounts of the total return of the trust (including both traditional income and capital appreciation of trust assets).
  • A beneficiary in a unitrust is entitled to the income amount based on a fixed percentage of the fair market value of the trust assets.
  • Under California law, a trustee may convert a trust into a unitrust unless it is expressly prohibited by the governing instrument.
  • "In no event ... may the court authorize conversion to a unitrust with a payout percentage of less than 3 percent or greater than 5 percent of the fair market value of trust assets." (California Probate Code Section 16336.5)

Most glaringly, it is when banks and trust companies pay themselves more each year than they distribute to trust beneficiaries. And a full or at least partial solution is the conversion of a traditional income trust into a unitrust. There are plenty of real-world cases that help make the choice both practical and ethical.

The impacts and risks to fiduciaries exercising their discretion to make income and principal distributions to beneficiaries is often the subject of continuing legal education. Stafford's April 23, 2019 CLE Webinar addresses part of the problem. The 90-minute Webinar explores these problems in the well titled "Discretionary Trust Distributions of Principal and Income: Avoiding Beneficiary Challenges and Adverse Tax Consequences."

The webinar's description certainly summarizes some of the problems:

"Determining whether and when to make a discretionary distribution of trust assets presents significant challenges for trustees and estate planning counsel in drafting trusts. Estate counsel must fully understand the impact and risks to a fiduciary in exercising discretion to make distributions, particularly of the trust principal, when structuring distribution provisions in discretionary trusts.

A discretionary trust is a type of complex trust that allows a trustee discretion over income or assets distributed to defined beneficiaries. Generally, trust documents specify standards for discretionary distributions. The most common measure is the health, education, maintenance, and support (HEMS) standard, defined in Treas. Reg. 20.2041-1(c)(1) as an 'ascertainable standard.'

Trust drafters may include other, "unascertainable" standards to guide fiduciaries. Absent careful drafting and thoughtful trustee selection, use of an unascertainable standard may trigger a tax recognition event such as a general power of appointment.

While courts generally give wide latitude to a trustee's exercise of discretion to make distributions, beneficiary challenges to distributions have succeeded in cases where the court finds flaws in the discretionary provisions or the trustee's exercise of distribution powers. Counsel must be fully aware of permissible standards to deter beneficiary disputes and avoid adverse tax consequences.

(The) experienced panel provides a practical guide to structuring distribution provisions in discretionary trusts, outlines liability risks involved, discusses appropriate factors, considerations, and standards, and examines potential creditor or other beneficiary claims arising from a trustee's decision to grant or deny a discretionary distribution request."

Hackard Law represents parties in trust beneficiary disputes - most often aggrieved and abused beneficiaries. We take significant California cases where we think that we can make a significant difference and there is a party whose wrongdoing or breach of duty who can be made financially accountable for their wrongdoing.

We focus our geographic practice in the probate and civil courts of Los Angeles, Orange, Santa Clara, San Mateo, Alameda, Contra Costa and Sacramento. If you would like to speak to us about your case, then call us at 916 313-3030. We'll be happy to hear from you.

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